Sunday, December 28, 2008

New York Times: How India Avoided the Crisis

No country nor system is perfect; certainly not India's. But this is an interesting view on how regulation actually works - and that human greed left to itself (to be it's own watchdog no less), will lead to bad outcomes. Contrary to dogma that has washed over the American psyche the past few decades - ironically those countries with the greatest lack of regulation are those being pole axed the hardest. Just coincidence I am sure. Both extremes (little regulation or massive regulation) generally lead to bad outcomes; certainly there must be happy mediums.

Each time regulation is brought up we hear about lack of innovation - as if they cannot co-exist. It's black or white. You can have regulation. Or innovation. But they cannot co-exist. It's political dogma advanced by those who would actually have to give up a cushy system for the greater good. As Mr. Obama says - it's time we get some adult supervsion; you can hear the scoffing at what we've done from thousands of miles away.
  • What has taken a number of us by surprise is the lack of adequate supervision and regulation,” Rana Kapoor was saying the other day. “This was despite the fact that Enron had happened and you passed Sarbanes-Oxley. We don’t understand it. Maybe it’s because we sit in a more controlled economy but ....” He smiled sweetly as his voice trailed off, as if to take the sting off his comments. But they stung nonetheless. Mr. Kapoor is an Indian banker, a former longtime Bank of America executive with a Rutgers M.B.A. who, along with his business partner and brother-in-law, Ashok Kapur, was granted government permission four years ago to start a private bank, which they called Yes Bank.
  • My hope in traveling to Mumbai was to learn about the current state of Indian business in the wake of both the credit crisis and the attacks. But in my first few days in this grand, sprawling, chaotic city, what I mainly heard, especially talking to bankers, was about America, not India.
  • How could we have brought so much trouble on ourselves, and the rest of the world, by acting in such an obviously foolhardy manner? Didn’t we understand that you can’t lend money to people who lack the means to pay it back? The questions were asked with a sense of bewilderment — and an occasional hint of scorn. Like most Americans, I didn’t have any good answers. It was a bubble, I would respond with a sheepish shrug, as if that were an adequate explanation. It isn’t, of course.
  • In India, we never had anything close to the subprime loan,” said Chandra Kochhar, the chief financial officer of India’s largest private bank, Icici. (that's because you lack innovation - only the best snake oil salesmen in the world could pull this off. USA! USA! USA!) “All lending to individuals is based on their income. That is a big difference between your banking system and ours.” She continued: “Indian banks are not levered like American banks. Capital ratios are 12 and 13 percent, instead of 7 or 8 percent. All those exotic structures like C.D.O. and securitizations are a very tiny part of our banking system. So a lot of the temptations didn’t exist.”
  • And when I went to see Deepak Parekh, the chief executive of HDFC, which was founded in 1977 as the country’s first specialized mortgage bank, practically the first words out of his mouth were these: “We don’t do interest-only or subprime loans. When the bubble was going on, we did not change any of our policies. We did not change any of our systems. We did not change our thought process. We never gave more money to a borrower because the value of the house had gone up. Citibank has a few home equity loans, but most banks in India don’t make those kinds of loans. Our nonperforming loans are less than 1 percent.” (Mr Parekh, in case you have not heard ... Greed, for the lack of a better word... is Good)
That all sounds nice and dandy but India was not much unlike the U.S. a few years ago...
  • Yet two years ago, the Indian real estate market — commercial and residential alike — was every bit as frothy as the American market. High-rises were being slapped up on spec. Housing developments were sprouting up everywhere. And there was plenty of money flowing into India, mainly from private equity and hedge funds, to fuel the commercial real estate bubble in particular. Goldman Sachs, Carlyle, Blackstone, Citibank — they were all here, throwing money at developers. (notice wherever they go, damage follows?)
  • So why did the Indian banks stay on the sidelines and avoid most of the pain that has been suffered by the big American banks? Part of the reason is cultural. Indians are simply not as comfortable with credit as Americans. “A lot of Indians, when you push them, will say that if you spend more than you earn you will get in trouble,” an Indian consultant told me. “Americans spent more than they earned.”
  • Mr. Parekh said, “Savings are important. Joint families exist. When one son moves out, the family helps them. So you don’t borrow so much from the bank.” Even mortgage loans tend to have down payments in India that are a third of the purchase price, a far cry from the United States, where 20 percent is the new norm. (Let’s not even think about what they used to be.)
  • But there was also another factor, perhaps the most important of all. India had a bank regulator who was the anti-Greenspan. His name was Dr. V. Y. Reddy, and he was the governor of the Reserve Bank of India. Seventy percent of the banking system in India is nationalized, so a strong regulator is critical, since any banking scandal amounts to a national political scandal as well. And in the irascible Mr. Reddy, who took office in 2003 and stepped down this past September, it had exactly the right man in the right job at the right time.
  • He basically believed that if bankers were given the opportunity to sin, they would sin,” said one banker who asked not to be named because, well, there’s not much percentage in getting on the wrong side of the Reserve Bank of India. For all the bankers’ talk about their higher lending standards, the truth is that Mr. Reddy made them even more stringent during the bubble.
  • Unlike Alan Greenspan, who didn’t believe it was his job to even point out bubbles, much less try to deflate them, Mr. Reddy saw his job as making sure Indian banks did not get too caught up in the bubble mentality. About two years ago, he started sensing that real estate, in particular, had entered bubble territory. One of the first moves he made was to ban the use of bank loans for the purchase of raw land, which was skyrocketing. Only when the developer was about to commence building could the bank get involved — and then only to make construction loans. (Guess who wound up financing the land purchases? United States private equity and hedge funds, of course!)
  • Then, as securitizations and derivatives gained increasing prominence in the world’s financial system, the Reserve Bank of India sharply curtailed their use in the country. When Mr. Reddy saw American banks setting up off-balance-sheet vehicles to hide debt, he essentially banned them in India. (I am being serious here - if you were not following it; contrast this to Sir Hank Paulson who about 15 months ago proposed a solution for the US banks problems - that is, create a super off balance sheet vehicle dubbed the Super SIV. That is how they could solve the problems. Create a fake bank, put the problem loans there, and ta-da - problem solved. Do you see how backwards we look to the rest of the world? Enron was helped by off balance sheet accounting. What did we do afterwards? We promoted this procedure in our banks! Even worse - the federal government does the same thing - the 2 wars are off balance sheet accounting. They are not part of our annual deficit. This is cultural - it is very deep and frankly, pathetic. If you have bad information - garbage in, garbage out. We hide information - and make decisions off incomplete info. That's our national "innovation" of late)
  • As a result, banks in India wound up holding onto the loans they made to customers. On the one hand, this meant they made fewer loans than their American counterparts because they couldn’t sell off the loans to Wall Street in securitizations. On the other hand, it meant they still had the incentive — as American banks did not — to see those loans paid back. (very old fashioned and NON innovative - keeping loans on your own balance sheet. Expecting loans to be paid back. WHERE is the innovation in that?)
  • Seeing inflation on the horizon, Mr. Reddy pushed interest rates up to more than 20 percent, which of course dampened the housing frenzy. He increased risk weightings on commercial buildings and shopping mall construction, doubling the amount of capital banks were required to hold in reserve in case things went awry. He made banks put aside extra capital for every loan they made. In effect, Mr. Reddy was creating liquidity even before there was a global liquidity crisis. (Can we get this Mr Reddy over in the US as Treasury Sect? Ah no - instead we'll have the head of the NY Federal Reserve - the regulator of regulators that was overseer of the banks that destroyed the global financial system as our Treasury head. Sounds like a plan - the markets loved it because he is one of "us"! A wink wink here, a nod nod there - business as usual soon enough)
  • Did India’s bankers stand up to applaud Mr. Reddy as he was making these moves? Of course not. They were naturally furious, just as American bankers would have been if Mr. Greenspan had been more active. Their regulator was holding them back, constraining their growth! (I find it far better to have unchecked growth, and then crashes, and then unchecked growth and crashes - it's been working wonders for the US the past decade. Who wants happy mediums? That's for backwards 3rd world countries. USA! USA! USA!)
  • “For a while we were wondering if we were missing out on something,” said Ms. Kochhar of Icici. Banks in the United States seemed to have come up with some magical new formula for making money: make loans that required no down payment and little in the way of verification — and post instant, short-term, profits. (and why would they do that? ah, executive compensation in a "heads you win, tails you also win" system - just turbo charge short term profits and if you leave a hulking mess of a company in your wake - you still get your fat paydays, and the US taxpayers can take care of the mess) As Luis Miranda, who runs a private equity firm devoted to developing India’s infrastructure, put it: “We kept wondering if they had figured out something that we were too dense to figure out. It looked like they were smart and we were stupid.”
  • At times like this, you tend to appreciate what he did more than we did at the time,” said Mr. Kapoor. “He saved us,” added Mr. Parekh.
  • As the credit crisis has spread these past months, no Indian bank has come close to failing the way so many United States and European financial institutions have. None have required the kind of emergency injections of capital that Western banks have needed. None have had the huge write-downs that were par for the course in the West.
  • When I asked Mr. Kapoor for his take on what had happened in the United States, he replied: “We recognize it as a problem of plenty. It was perpetuated by greedy bankers, whether investment bankers or commercial bankers. The greed to make money is the impression it has made here. Anytime they wanted a loan, people just dipped into their home A.T.M. It was like money was on call.”
A compare and contrast of systems if you will - plus we've been investors in ICICI Bank (IBN) and HDFC (HDB) - both stocks have been perking up quite nicely of late. Lost in the constant hubbub about China, is the forgotten stepchild India - with less reliance on exports (just over 20% of the economy) it might have a chance to fare better in 2009; should be an interesting year.

After reading all that let me remind (I had a fraction of readers back then) what I wrote in October 2007 as my ironic quote of the month, year, and perhaps decade - as the a most striking indictment of the pathetic con job of 'financial innovation'

Emerging markets are being favored in part because "financial innovations are less common in developing countries," said Heidemarie Wieczorek-Zeul, German economics minister, in remarks to the IMF/World Bank Development Committee.

And this folks is one reason our financial system is still on life support - we still continue to have off balance sheet accounting (hiding stuff) and lack of transparency - hence a lack of trust. Our Federal Reserve will not even disclose what it has on its books to news agencies - and its our REGULATOR. Oh, I'm sorry - that's innovative.

Off to stare at panda pictures as I fall off the soap box....

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